If personal financial inclusion has to graduate from being a personal finance product to a self-sustaining process, it will have to be accompanied by financial inclusion for small- and medium- enterprises (SMEs).

And for that, it is not enough to stipulate regulated lending to or set up a distribution network for SMEs. SMEs will get access to effective finance only when SME lending is part of a larger financing system that comprises different types and tenors of lending, an SME-focused policymaker, an SME-focused bank, a credit guarantee mechanism, provisions for venture capital firms, and much else. In other words, the financial system’s architecture as a whole has to change much more than individual initiatives and institutions.

Quite a few of the basic building blocks to create the new architecture already exist. What is required is to tie up all the loose threads and build a complete conceptual and operating framework to help SMEs.

The new national financial architecture must reflect the capacity for and stage of development in India’s financial markets, for instance, the mechanisms of providing loans, giving credit guarantees or infusing equity capital into SMEs. The current set-up, in the neo-classical economic tradition, is unfortunately designed for and devoted to a corporate economy.

The starting point has to be the recognition that almost half of the total manufacturing output in the economy is originating from a segment that is, first, spatially dispersed; second, operating on a small scale (an average of three people per enterprise); third, sectorally diverse with high credit risk; and, last, with no credit history. Perhaps we should then be thinking of alternative means of finance—instead of just banking-driven loan markets (where factors such as credit history are so key), SMEs can tap capital markets.

While the Securities and Exchange Board of India (Sebi) earlier this year revised the regulatory framework for SMEs accessing capital markets, it continues to take a very narrow view by defining the SME exchange as one trading platform of a stock exchange that otherwise has nationwide trading terminals. This is a purely transactional approach.

Regulators must recognize an SME exchange has to be a repository of advisory and knowledge capital prior to being driven by transactions. Unlike corporates, SMEs are not just short of capital, but also have very limited access to information. Therefore, any framework for capital markets in this case should be a knowledge exchange that proactively seeks to take firms up their evolutionary cycle.

The listing process has thankfully been made easier with the model listing agreement released in May to list on an SME exchange; this process is less restrictive compared with the listing requirements on the main bourses. The listing agreement even permits migration from an SME exchange to a main exchange (such as the Bombay Stock Exchange).

“Market making"—providing liquidity for shares—is mandatory in SME public offerings. It is the responsibility of the merchant banker to ensure some market making on the SME exchange for a minimum period of three years from the date of listing.

Such rules and mechanisms don’t exist for usual exchanges. And more basic exemptions are required to make SME exchanges work. For instance, Sebi’s takeover code—the rules for one entity to buy a publicly listed one—should not be applied for SMEs on this platform, and investors trading on this platform should be exempt from short-term capital gains tax.

While these are necessary conditions for getting SME exchanges started, these will not address the basic issue. The real problem with earlier attempts at successfully running a junior exchange such as the OTC Exchange of India or the Indo-next platform on the Bombay Stock Exchange has been that these are national, whereas the small business by definition are regional. Even as the guidelines, criteria and even parentage become nation-wide, SME exchanges must be regional; not just in their spread, but also in their location and activity.

As such, instead of trying to recreate a new institution, it may be a better idea to convert all the 20-odd regional exchanges into exclusively SME exchanges, preferable with a single ownership structure. This will, in the bargain, also revive the fortunes of all the regional bourses who are otherwise in the throes of death.

The new architecture for SME financing will have to be supported by an appropriate legal framework. Not only because financial markets are not well developed, but also since inefficient legal protections disproportionately increase financial restrictions for creditors.

Haseeb A. Drabu is former chairman and chief executive of Jammu and Kashmir Bank. He writes on monetary and macroeconomic matters from the perspective of policy and practice. Comment at haseeb@livemint.com

To read Haseeb A. Drabu’s previous articles, go to www.livemint.com/methodandmanner